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Home > Investments > European

Leaders should boost growth

Europe needs ‘creative destruction’ if it is to escape its funk

By Mark Page | Published Sep 03, 2012 | comments

History is replete with complacent firms falling from leader to laggard in an industry.

At the end of 2007, Nokia was the undisputed global leader in mobile devices with a market share of 40 per cent. Fast forward five years, and Nokia’s market share at the end of the second quarter of 2012 was below 20 per cent. The company underestimated the emerging competition from Samsung and was too slow to address the smartphone market. Its difficulties continue.

The technology space is particularly unforgiving. Companies have to embrace change and reinvent themselves periodically. One such good example is Software, a leader in business infrastructure software solutions. In 2006, three quarters of its revenues were coming from database management and application development, a high-margin but mature business. The temptation would have been to allocate most of the firm’s resources to defend its margins and try to slow down the rate of decline. Software’s management took the courageous, and ultimately successful, step instead to allocate more resources to a smaller but fast-growing division, Business Process Excellence, which benefits from digitisation and the growth of cloud computing. From 2006 to 2011, the compounded average growth rate of this division was 33 per cent (compared to 1 per cent for the ‘legacy’ division) and it is forecast to represent 70 per cent of total sales by 2015.

Had European leaders emulated Software’s strategy of embracing creative destruction, the European crisis would not have lasted so long. Instead, European decision makers have tried to find palliatives to the crisis instead of solving it and have made things worse in the process. Due to the unsustainable amount of debt in Spain and Italy, international private investors have left the periphery of Europe en masse. The European Central Bank actually facilitated that process with its two long-term refinancing operations, the perverse side effects of which were renationalising debt markets, keeping afloat otherwise insolvent banks and slowing down the necessary and inevitable restructuring of the banking systems in Europe. Now Mr Draghi is talking about putting a cap on the discrepancies between European government bond yields. This would cheer government officials but also remove a powerful incentive to tackle the issues at stake.

What should be done then? Embrace creative destruction? Perhaps Europe should stop saving insolvent institutions and bailing out oblivious investors and use the money instead to boost growth. The European oversight of the Spanish banking bailout and the creation of the Spanish ‘bad bank’ is a (timid) step in the right direction. It is a shame it took European leaders three years to implement these steps.

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